We live in a highly mobile world: individuals regularly relocate for work and professional reasons, and families are more international than they have ever been due to multiple nationalities and residences, and the general trend towards increased travel. It is critical for persons relocating to another country to consider the financial and tax impact of such relocation, including whether any exit or departure taxes exist (in both the country of current residence and the country of relocation). Particularly noteworthy is the rise in exit taxes around the world and the strengthening of such regimes.
Generally, an exit tax is imposed on individuals who cease to be tax residents of one country and relocate to another country. In the United States, where taxation is based also on citizenship, there is a special exit tax triggered upon relinquishment of citizenship (also applicable to long-term green card holders). In both scenarios exit taxes can be either “immediate,” “trailing,” or a combination of both.
An immediate exit tax is generally imposed on unrealized capital gains, assessed as of the last day of residency or citizenship of the taxpayer. The taxpayer is deemed to have engaged in a sale of the assets, and will therefore be taxed on the built-in (and unrealized) gain in his assets. The sale is deemed to occur immediately before the taxpayer changes his or her tax status. The assessment of the built-in gain varies between recognition of the entire built-in gain or recognizing only appreciation in the assets arising following the taxpayer’s migration to the country in question. For example, under the U.S. federal exit tax [Internal Revenue Code Section 877A], a taxpayer can elect to “step-up” his basis for property that is subject to the Exit Tax to the fair market value on the day that the individual first became a resident of the United States. However, as an example, the step-up-in basis rule should not be available with respect to U.S. real property interests. [IRS Notice 2009-85, Section 3.D].
Because taxpayers may lack the liquidity to pay for a tax imposed on a fictitious sale, many countries offer payment deferral options. Under such a deferral scheme, the taxpayer will generally only be obligated to pay the tax calculated at the time of relocation once the taxpayer disposes of the assets that triggered the exit tax in the first place. However, in order to benefit from payment deferral options, taxpayers may be required to pledge financial guarantees, file tax declarations or appoint representatives.
In certain cases, an exit tax will also serve to accelerate previously recognized income. For example, in a recent European Court of Justice (“ECJ”) case, the ECJ challenged the validity of a Spanish income tax provision which provided that:
“Where the person concerned loses his status as taxpayer as a result of a change in residence, all his income which has not yet been charged to a tax period must be included in the tax base corresponding to the last tax period for which an income tax return must be filed, in accordance with the conditions laid down by law and, where appropriate, in return for a complementary self-assessment without any penalty, or interest charged for late payment or tax surcharge.” [Article 14(3) of Law 35/2006 on personal income tax and amending in part the laws on the taxation of corporations, of the income of non-residents and of wealth (Ley 35/2006 del Impuesto sobre la Renta de las Personas Físicas y de modificación parcial de las leyes de los Impuestos sobre Sociedades, sobre la Renta de no residentes y sobre el Patrimonio) of 28 November 2006, referred to in (Case C-269/09) Commission v Kingdom of Spain, ]
At least within the context of intra-EU relocations, the requirement to post financial guarantees has been found to violate the freedom of establishment and the freedom of workers under EU law [(Case C-9/02) Hughes de Lasteyrie du Saillant, ; (Case C-470/04) N. v. Inspecteur, ]. On the other hand, the ECJ has recognized that the obligation to file a tax return at the time of the transfer of residence is a proportionate objective for a Member State to apply [N. v. Inspecteur; Communication from the Commission to the Council, the European Parliament and the European Economic and Social Committee - Exit taxation and the need for co-ordination of Member States' tax policies [COM(2006) 825].
The recent introduction of the Spanish Exit Tax regime provides for a deferral of the Exit Tax where the loss of residence is due to a transfer for employment related reasons to a non-tax haven jurisdiction, or where the taxpayer relocates to an EU or EEA country with an effective exchange of information agreement, provided that the taxpayer complies with certain holding period and reporting requirements. Similarly, changes to Austria’s Exit Tax Regime that became effective on January 1, 2016, preserve the deferral of the Exit Tax in certain cases where the taxpayer relocates within the EU or to an EEA country with an effective exchange of information agreement. In all other cases the tax can be distributed equally over the duration of seven years upon the taxpayer's request.
The trend towards greater transparency and the exchange of information between tax authorities should mean that deferral of exit taxes will become the standard solution, at least for taxpayers relocating within the EU or EEA. This development is to be welcomed, because the imposition of an exit tax upon immediate relocation (rather than upon the effective sale of the assets) may present problems of valuation and liquidity for taxpayers. In particular, taxpayers may be required to pay the exit tax when they would not otherwise have the corresponding liquidity generated by the actual sale of the assets. Similarly, the fair market value of certain assets may be difficult to hypothetically estimate in the absence of a real sale.
From a policy standpoint, exit taxes may be explained as an imposition of costs on taxpayers who have availed themselves of the infrastructure and society of the country (that is, the “Departing Country”), which in turn has resulted in an unrealized increase in wealth of the taxpayer. This cost is then imposed at the time when those taxpayers decide to permanently leave the Departing Country, before the Departing Country loses its taxing rights over the taxpayer. The exit tax therefore enables the Departing Country to wreak the benefit of having fostered a place where wealth could be created and grow.
However, one of the greatest dangers in the field of exit taxation is the risk of double or triple taxation. While the Departing Country may have a policy justification for taxing the “unrealized gain” attributable to the taxpayer’s period of residence in the Departing Country, the risk is that the Immigrating Country may tax the entirety of the gain upon the taxpayer’s ultimate disposition of the asset, resulting in double taxation of at least a portion of that gain. Alternatively, the Departing Country may impose an “immediate” exit tax upon relocation, even though, once the taxpayer ultimately sells these assets, their value may have substantially decreased, with the consequence that the taxpayer is taxed on phantom income.
Some mechanisms that could help alleviate the risk for double taxation include the Immigrating Country granting a “step-up” in basis to the fair market value on the date of relocation. Alternatively, in the case of a deferred payment exit tax, the Departing Country could grant a credit for the taxes paid to the Immigrating Country upon disposition of the assets that corresponds to the portion attributable to the taxpayer’s holding period when a resident of the Departing Country. This is the solution that Japan has adopted in certain cases when a taxpayer disposes of assets that are subject to the Exit Tax, and has elected to defer taxation. [Amended Income Tax Law 95-2(1) and ITL 153-5].
Because of the harsh impact of exit taxes on an increasingly mobile society, efforts to coordinate the respective taxing rights and alleviate double taxation should probably be coordinated through the formal revision of tax treaties and conventions.
In conclusion, the recent pressure on government budgets means that exit taxes are unlikely to disappear any time soon. While the increase in information exchange may encourage tax authorities to allow the deferral of exit taxes until the effective disposition of the taxpayer’s assets, the possibility of double taxation between the Departing and Incoming Country are issues that must be carefully considered.